Buffett's Biggest Mistakes

Warren Buffett is widely regarded as one of the most successful investors of all time. Yet, as Buffett is willing to admit, even the best investors make mistakes. Buffett's legendary annual letters to his Berkshire Hathaway shareholders tell the tales of his biggest investing mistakes.There is much to be learned from Buffett's decades of investing experience, so I have selected three of Buffett's biggest mistakes to analyze. (Learn about Buffett's investing life in Warren Buffett: The Road To Riches.)

ConocoPhillipsMistake: Buying at the wrong price

In 2008, Buffett bought a large stake in the stock of ConocoPhillips as a play on future energy prices. I think many might agree that an increase in oil prices is likely over the long term, and that ConocoPhillips will likely benefit . However, this turned out to be a bad investment, because Buffett bought in at too high of a price, resulting in a multibillion dollar loss to Berkshire. The difference between a great company and a great investment is the price at which you buy stock and this time around Buffett was "dead wrong". Since crude oil prices were well over $100 a barrel at the time, oil company stocks were way up.

Lesson LearnedIt's easy to get swept up in the excitement of big rallies and buy in at a prices that you should not have - in retrospect. Investors who control their emotions can perform a more objective analysis. A more detached investor might have recognized that the price of crude oil has always exhibited tremendous volatility and that oil companies have long been subject to boom and bust cycles.

Buffett bought preferred stock in U.S. Air in 1989 - no doubt attracted by the high revenue growth it had achieved up until that point. The investment quickly turned sour on Buffett, as the U.S. Air did not achieve enough revenues to pay the dividends due on his stock. With luck on his side, Buffett was later able to unload his shares at a profit. Despite this good fortune, Buffett realizes that this investment return was guided by lady luck and the burst of optimism for the industry. (You may not believe it, Buffett is jealous of the small-time investor. Read about it in Why Warren Buffett Envies You.)

Lesson LearnedAs Buffett points out in his 2007 letter to Berkshire shareholders, sometimes businesses look good in terms of revenue growth, but require large capital investments all along the way to enable this growth. This is the case with airlines, which generally require additional aircraft to significantly expand revenues. The trouble with these capital intensive business models is that by the time they achieve a large base of earnings, they are heavily laden with debt. This can leave little left for shareholders, and makes the company highly vulnerable to bankruptcy if business declines.

Buffett says: "Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it."

Dexter ShoesMistake: Investing in a company without a sustainable competitive advantage

In 1993, Buffett bought a shoe company called Dexter Shoes. Buffett's investment in Dexter Shoes turned into a disaster because he saw a durable competitive advantage in Dexter that quickly disappeared. According to Buffett, "What I had assessed as durable competitive advantage vanished within a few years." Buffett claims that this investment was the worst he has ever made, resulting in a loss to shareholders of $3.5 billion.

Lesson LearnedCompanies can only earn high profits when they have some sort of a sustainable competitive advantage over other firms in their business area. Wal-mart has incredibly low prices. Honda has high quality vehicles. As long as these companies can deliver on these things better than anyone else, they can maintain high profit margins. If not, the high profits attract many competitors that will slowly eat away at the business and take all the profits for themselves.

Buffett says: "A truly great business must have an enduring "moat" that protects excellent returns on invested capital."

The Bottom LineWhile making mistakes with money is always painful, paying a few "school fees" now and then doesn't have to be a total loss. If you analyze your mistakes and learn from them, you might very well make the money back next time. All investors, even Warren Buffett, must acknowledge that mistakes will be made along the way. (We've seen his mistakes, but his triumphs are even more impressive. Check out Warren Buffett's Best Buys.)